GLOBANT SA GLOB S
January 10, 2020 - 9:00am EST by
Hamilton1757
2020 2021
Price: 113.00 EPS 2.15 2.15
Shares Out. (in M): 38 P/E 53 53
Market Cap (in $M): 4,300 P/FCF 0 0
Net Debt (in $M): 60 EBIT 105 105
TEV ($): 43,560 TEV/EBIT 41 41
Borrow Cost: General Collateral

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Description

Overview: Generating revenue abroad and paying employees based in Argentina, GLOB is, for all intents and purposes, an Argentinian exporter of IT consulting services. Just like any exporter, when the peso (ARS) is depreciating, GLOB benefits as $ costs effectively decrease in the short term (the currency adjusts downward faster than peso salaries adjust upwards). But too much of a good thing is usually bad... and that’s what we have here now that  a 30% spread has developed between the official peso (pegged @ 60/1 USD) and the “black market” peso (77/1). Going forward, GLOB’s costs are effectively growing at the black market rate while the ARS/USD exchange rate remains unchanged (peso salaries will inflate quickly while the exchange rate remains flat), forcing the company to pay a “tax” on repatriated dollars used to pay wages in Argentina. 

 

 

Background: Prior to 2015, Argentina had a system of currency controls/export taxes designed to help the government meet its annual budget and build FX reserves without tapping financial markets. This changed after Macri’s election in 2015... controls were rolled back/eliminated in concert with the country’s sovereign default settlement (related to 2001 default). But the good times never really materialized and with economic problems persisting (inflation, peso devaluation, continued trade deficits, etc), Alberto Fernandez (and Cristina Fernandez de Kirchner) defeated Macri in the August 2019 primary. The surprise (landslide) defeat prompted currency controls to be implemented once again on 9/1/19 (@ 60 ARS/$). Macri’s subsequent defeat in the general election of October 2019 means the old guard is back in power (officially as of 12/10/19)... so expect old policies to be used to manage the economy for the foreseeable future. 

Without access to capital markets (the country has started restructuring negotiations w/ IMF and bondholders) and the post-election currency controls still in place, Argentina needs to both plug its budget deficit and raise $ revenue. In late December 2019, the new government announced an Economic Emergency bill which included the follow reforms: 1) an increase in export taxes (soybeans from 25% to 33%, beef from 7% to 15%, and corn/wheat from 7 to 15%); and 2) a 30% tax on all FX transactions. The bill also included new income/wealth taxes, increases in social security payments, and freezes to utility prices... but the two listed are the major initiatives. As a result of these policies (designed to raise dollar revenue) the black market peso has fallen significantly and trades at a ~30% discount to official ARS/USD levels.

GLOB is a US listed stock headquartered in Luxembourg, but it’s an Argentina company. GLOB’s management team and board are all Argentine. The corporate office is in BA. ~30% of its workforce is located in Argentina (albeit down from 70% in 2014). As an Argentinian IT exporter, GLOB earns USD revenue and uses that cash to pay its Argentinian workforce in pesos. When capital controls are in place, domestic costs (white collar salaries) inflate at a rate closer to the black market peso rather than the official exchange rate... meaning GLOB needs to covert USD into ARS at unofficial rates or be subject to a “black market tax” equaling the difference between the official and black market exchange rates.

When capital controls were last in place (2011-15), GLOB circumvented the effective “black-market tax” by buying US$ denominated, Argentine law, sovereigns (BONARs). After holding them for a short, required period of time, GLOB’s Argentinian subsidiaries would then sell these bonds in Argentina for peso proceeds that were close to the implied “black market” exchange rate (read about it in the 20F risk factors). While GLOB could once again buy/sell BONARs to circumvent the “tax”, it’s not so easy this time. Prior to 2015 the country was “negotiating” w/ holdouts (from 2001 & 2010 restructurings) and was steadfast that these BONAR bonds would be repaid in full. As such, the BONARs were liquid, stable and eventually paid in full. Today’s BONARs aren’t that... they will be part of Argentina’s next restructuring. The value of these bonds are extremely volatile (8.75% of 2024 trading @ ~40) and will be permanently impaired (they trade wide to English law bonds). They are not suitable instruments, nor is any other security, to hedge the $/ARS black market currency spread. Anecdotally – have heard that there is very little volume/interest in BONARs from large traders, supporting the supposition that they are not being used today to circumvent the “tax”. 

Thesis: With USD fixed price contracts and 80% of total operating costs in salaries, GLOB is acutely exposed to movements in FX – the Argentine Peso specifically. (PF for the recent Bellatrix acquisition, 30%+ of GLOB employees and most senior mgmt. are based in Argentina.) So now, when GLOB brings USD back to Argentina to pay its employees in pesos... it converts at the official rate. The problem is salaries for these white collar workers and senior mgmt. are going to increase at a rate closer to the black market rate – or ~30% higher. The difference between the two is a tax... and a significant one for a company like GLOB. 

Even more troubling for GLOB, if history is any guide... the black market tax could widen from here as it did during the two year period prior to Macri’s election in 2015 when it averaged 55%. 

 

Now, GLOB can pass on some of that tax to its employees – maybe resulting in attrition in Argentina (this has already been reported) and new jobs in Colombia. Or maybe GLOB tries to pass some costs onto customers in new contracts – but presumably that hurts competitive positioning/revenue growth outlook. They could increase the equity component paid to senior mgmt. Just what they’re going to do isn’t clear... but the magnitude of the problem they face is enormous considering estimated 2019 operating income of $85m. Presumably back half of 2020 numbers need to come down materially. (The impact of the tax likely won’t be felt until q3 19 as the magnitude of the peso decline post the primary (8/11/19) will likely offset the black market tax impact for some time.)

 GLOB claims its Peso exposure is de minimis @ 5%. They argue: 1) while Argentine employees represent 30% of total, they only represent 18% of “cost basis” because argentine employees are paid less than employees elsewhere; and 2) peso exposure is further reduced from 18% to 5% through USD 3m rolling hedges and pegging management salaries to the dollar. (Cost basis is defined as all costs – 80% of which are salaries.) Regarding...

 1: I find this hard to believe considering all of senior management is based in Argentina... but defer to the company. Could salaries really look like this? Argentines getting paid 40% of what employees in Colombia, Mexico and India? 

 

2: Neither hedging Pesos nor pegging management salaries to the dollar work in the new currency regime. Hedging a pegged currency absent some sort of catalyst won’t work. Pegging salaries to the USD means in real terms management would be taking a 30% haircut when converting USD into ARS. The only way to actually do this would be for management to have opened international bank accounts to accept USD – and argentine tax authorities would have a real issue with this.

As an aside, the strangest part of conversations with management is that while they admit they need to hedge the black market tax just like they did previously with BONARs, the methods they are using/exploring won’t work. This could be due to the fact that: 1) the tax widened has just occurred in the last month; 2) currency depreciation will offset tax for some time; 3) management is receiving USD salaries in international bank accounts. In addition, it’s strange how they also claim at times (??) they won’t be subject to these taxes because they are bringing $’s into the country... and fail to acknowledge Argentine export taxes on agricultural products/oil/etc. 

Other concerns: 1) GLOB has been a 10xer since its 2014 IPO and off 2019 numbers trades @ 40x unadjusted EBITDA, 6.6x revenues and 75x EPS; 2) the company inflates organic revenue growth with misleading disclosures around revenue contributions from acquisitions – for example, on a 8/15/19 call, saying, “it is becoming more complicated to answer that, because as you know we integrate very fast... so it’s not easy to say, the revenues were organic or inorganic” (yet somehow the company uses contingent consideration payments based on year forward revenue targets for every acquisition and can’t calculate organic growth?); 3) Insiders have dumped huge amounts of stock since the IPO; 4) the company never generates significant FCF – doesn’t even disclose quarterly cf statements; 5) quarterly revenue beats becoming less and less convincing – Southwest delay again in q4?; 6) most recent quarter showed significant decline (16%) in larger customer revenue; and most important 7) GLOB announced the acquisition of another Argentinian IT “exporter” for $70m 1 day ($USD!!!!!?!?!?!?!?!?!?!?!?!?!?!?) after president Macri was dealt that surprise defeat in the country’s primary (8/11/19), the day the ARS plunged nearly the 50% and 2.5 weeks before the country implemented currency controls (9/1/19).

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

 

Catalysts: It doesn’t seem like numbers are coming down when they issue 2020 guidance (expect 20%+ organic growth and ~17% adj op income). IR seems committed to the narrative that peso exposure is limited. Back half of 2020 is when we should see the impact from the black market tax (for the reasons noted above). Something disturbing is revealed about Bellatrix acquisition/timing or management compensation practices. Customers become increasingly wary of contracts with GLOB due to risks around outsourcing to Argentina (political/social instability?). Black market tax rate increases.

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